Chapter 4, Problem 35CP

a.

Explanation of Solution

Costs and benefits required for implementing Inventory Tracking System at American Labs:

The costs for implementing Inventory Tracking System at American Labs include:

• One-time costs
  • It is the cost associated with starting phases of a project during project initiation and planning.
• Recurring costs
  • It is the cost that results from present evolution and use of the proposed system.

The benefits for implementing Inventory Tracking System at American Labs:

• Tangible benefits
  • These are the benefits that can be estimated properly during the course of the project...

b.

Explanation of Solution

Economic feasibility analysis for implementing inventory tracking system:

Monetary benefits of an information system = $50,000 per year.

One-time costs = $80,000

Recurring cost = $25,000 per year.

Discount rate = 10%

Time period = 5 years

Present value for benefits and costs can be calculated by using the formula:

    ${\text{PV}}_{\text{n}}\text{= Y × 1/}{\left(\text{1+i}\right)}^{\text{n}}$

Here PV_n is the present value and i is the discount rate.

Present value (PV) calculation for benefits:

Benefits starts from year 1, hence calculation of present value starts from year 1.

${\text{PV}}_{\text{0}}\text{= 0 }\times \text{ 1 / }{\left(\text{1+ 0}\text{.10}\right)}^{\text{0}}\text{= 0}\times \text{1 = 0}$

${\text{PV}}_{\text{1}}\text{= 50,000 × 1/ }{\left(\text{1+}\text{.10}\right)}^{\text{1}}\text{= 50,000×0}\text{.909 = 45,450}$

${\text{PV}}_{\text{2}}\text{= 50,000 × 1/ }{\left(\text{1+}\text{.10}\right)}^{\text{2}}\text{= 50,000×0}\text{.8264 = 41,320}$

${\text{PV}}_{\text{3}}\text{= 50,000×1/ }{\left(\text{1+}\text{.10}\right)}^{\text{3}}\text{= 50,000×0}\text{.7513= 37,565}$

${\text{PV}}_{\text{4}}\text{= 50,000×1/ }{\left(\text{1+}\text{.10}\right)}^{\text{4}}\text{= 50,000×0}\text{.683 = 34,150}$

${\text{PV}}_{\text{5}}\text{= 50,000×1/ }{\left(\text{1+}\text{.10}\right)}^{\text{5}}\text{= 50,000×0}\text{.6209 = 31,045}$

Net Present Value (NPV) for benefits:

$\begin{array}{l}NPV=P{V}_0+P{V}_1+P{V}_2+P{V}_3+P{V}_4+P{V}_5\hfill \\ {}_{ }=0+45,450+41,320+37,565+34,150+31,045\hfill \\ =189,530\hfill \end{array}$

Present Value (PV) for costs:

${\text{PV}}_{\text{0}}\text{= 80,000×1/ }{\left(\text{1+}\text{.10}\right)}^{\text{0}}\text{= 80,000×1 = 80,000}$

${\text{PV}}_{\text{1}}\text{= 25,000×1/ }{(\text{1+}}^{}$

c.

Explanation of Solution

Modified Economic Feasibility Analysis for implementing inventory tracking system at discount rate(11%):

Monetary benefits of an information system = $50,000 per year.

One-time costs = $80,000

Recurring cost = $25,000 per year.

Discount rate = 11%

Time period = 5 years

Present value for benefits and costs can be calculated by using the formula:

  ${\text{PV}}_{\text{n}}\text{= Y × 1/}{\left(\text{1+i}\right)}^{\text{n}}$

Here PV_n is the present value and i is the discount rate.

Present value (PV) calculation for benefits:

Benefits starts from year 1, hence calculation of present value starts from year 1.

${\text{PV}}_{\text{0}}\text{= 0 }\times \text{ 1 / }{\left(\text{1+0}\text{.11}\right)}^{\text{0}}\text{= 0}\times \text{1 = 0}$

 ${\text{PV}}_{\text{1}}\text{= 50,000 × 1/ }{\left(\text{1+}\text{.11}\right)}^{\text{1}}\text{= 50,000×0}\text{.9009 = 45,045}$

${\text{PV}}_{\text{2}}\text{= 50,000 × 1/ }{\left(\text{1+}\text{.11}\right)}^{\text{2}}\text{= 50,000×0}\text{.8116 = 40,580}$

$P{V}_3=\text{ 50},000\times 1/{\left(1+.11\right)}^3=\text{ 25},000\times 0.7311=\text{ 36,555}$

${\text{PV}}_{\text{4}}\text{= 50,000×1/ }{\left(\text{1+}\text{.11}\right)}^{\text{4}}\text{= 50,000×0}\text{.6587 = 32,935}$

${\text{PV}}_{\text{5}}\text{= 50,000×1/ }{\left(\text{1+}\text{.11}\right)}^{\text{5}}\text{= 50,000×0}\text{.5934 = 29,670}$

Net Present Value (NPV) for benefits:

 $\begin{array}{l}NPV=P{V}_0+P{V}_1+P{V}_2+P{V}_3+P{V}_4+P{V}_5\hfill \\ {}_{ }=0+\text{ 45,045 + 40,580 + 36,555 + 32,935 + 29,670 }\hfill \\ =\text{ 184,785}\hfill \end{array}$

Present Value (PV) for costs:

${\text{PV}}_{\text{0}}\text{= 80,000×1/ }{\left(\text{1+}\text{.11}\right)}^{\text{0}}\text{= 80,000×1 = 80,000}$

${\text{PV}}_{\text{1}}\text{= 25,000×1/ }{\left(\text{1+}\text{.11}\right)}^{\text{1}}\text{= 25,000×0}\text{.9009 = 22,522}$

${\text{PV}}_{\text{2}}\text{= 25,000×1/ }{\left(\text{1+}\text{.11}\right)}^{\text{2}}\text{= 25,000×0}\text{.8116 = 20,290}$

$P{V}_3=\text{ 25},000\times 1/{\left(1+.11\right)}^3=\text{ 25},000\times 0.7311=\text{18,277}$

${\text{PV}}_{\text{4}}\text{= 25,000×1/ }{\left(\text{1+}\text{.11}\right)}^{\text{4}}\text{= 25,000×0}\text{.6587 = 16,467}$

${\text{PV}}_{\text{5}}\text{= 25,000×1/ }{\left(\text{1+}\text{.11}\right)}^{\text{5}}\text{= 25,000×0}\text{.5934 = 14,835}$

Net Present Value (NPV) for costs:

$\begin{array}{l}NPV=P{V}_0+P{V}_1+P{V}_2+P{V}_3+P{V}_4+P{V}_5\hfill \\ =\text{ 80,000 + 22,522 + 20,290 + 18,277 + 16,467 + 14,835}\hfill \\ =\text{ 172,392}\hfill \end{array}$

Overall Return on Investment (ROI):

Overall return on investment can be calculated as:

$\text{Overall ROI = }\left(\text{Overall NPV / NPV of all costs}\right)$

$\begin{array}{l}\text{Overall NPV = }\left(\text{NPV of all benefits – NPV of all costs}\right)\hfill \\ \text{ = 184,785 – 172,392}\hfill \\ \text{ = 12,393}\hfill \end{array}$

$\begin{array}{l}\text{Overall ROI = 12,393 / 172,392}\hfill \\ \text{ = 0}\text{.07}\hfill \end{array}$

Break-Even Analysis (BEA):

• Break even analysis is carried out by determining NPV of yearly cash flows.
• The yearly cash flows are calculated by subtracting present values of recurring costs from the present value of yearly benefits.
• The overall NPV cash flow is total cash flow of the preceding years.
• After determining NPV yearly cash flows, it is found that break even occurs between years three and four.
• This is because here overall NPV is positive.

Modified Economic Feasibility Analysis for implementing inventory tracking system at discount rate (14%):

Monetary benefits of an information system = $50,000 per year